Is the ‘Fragile’ Steel Industry Showing Signs of Stability?

Steelmakers around the globe continued to face stiff headwinds in 2015. The combination of industry overcapacity, falling prices and the export of steel from China added up to the worst industry downturn in 50 years.

Here in the United States, imports took 25% of the U.S. domestic market last year, according to the American Iron and Steel Institute. U.S. steelmakers have recovered somewhat thanks to capacity cuts and the imposition of tariffs on some steel imports.

The CEO ofU.S. Steel(NYSE: X), Mario Longhi, said the company would use every tool available to “fight for fair trade.”

However, the domestic steel industry cannot remain insulated against what is going on with the global steel industry.

Peak Steel

Steel exports continue to flow out of the country. Exports rose 9.4% in the January-April period from a year ago. In 2015, steel exports hit almost 100 million metric tons. That’s nearly Japan’s entire annual steel output!

China does consume vast quantities of steel. But officials from the China Steel and Iron Association have said demand there has peaked. The concept of “peak steel” in China is now a reality.

That leaves huge overcapacity in China’s steel industry. The overcapacity is estimated to be in the 300 million ton range.

The good news is that China’s central government has plans to cut about 100-150 million tons of that overcapacity over the next five years. In fact, some plants have already been shut down. But here is where it gets interesting…

Higher Prices Are Bad News

China’s plans to close inefficient, money-losing steel plants have been dealt a blow by, of all things, Chinese speculators. With tight restrictions on property and stock market speculating, Chinese speculators found an outlet in the commodities market.

Steel rebar futures, traded in Shanghai, soared on volume that even exceeded the volume on West Texas Intermediate and Brent crude oil futures contracts. These Chinese speculators pushed the price of steel up about 50% in a short period of time. Chinese steel prices had been in a steady downtrend for the past five years.

This sudden surge in prices kept zombie steel companies open and brought others back to life. All of a sudden, these corporations were as profitable as they were back in 2009.

The good news is that Chinese regulators quickly stepped in. They imposed increased fees and margin requirements on speculation in commodities. That sent steel rebar prices downward again. Hopefully, normalcy will resume with Chinese steel prices. That should get the shutdown of excess capacity back on the tracks again.

If that happens, where does that leave the steel industry?

That answer came from the world’s biggest steelmaking company, ArcelorMittal (NYSE: MT).

Thanks to continuing Chinese overcapacity, ArcelorMittal says the global steel market remains “fragile.” The company’s refusal to raise its earnings guidance for the year reflects that caution. One good note was that the company stated it was seeing a recovery in spreads – that is, the difference between its raw material costs and steel prices in many markets was returning to “more sustainable levels.”

Other companies recently hinting at a recovery in the steel market include U.S. Steel, AK Steel Holding Corp. (NYSE: AKS) and Nucor (NYSE: NUE).

But the harsh reality is that, when it comes to steel, what happens in China doesn’t stay in China.

The key to the industry’s health is reliant on Chinese policy. I do believe the leadership there is serious about shutting down steel capacity, if only to reduce the pollution produced by the steel producers.

But it will be a time-consuming slog. Until then, the steel industry and steel stocks remain fragile.

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